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The purpose of this research is to study financial derivatives from multiple angles. It involves a critical examination of the features and functioning of financial derivatives. It also evaluates the impact of derivatives on the financial system and economy, primarily in the context of various financial crises, including Global Financial Meltdown of 2008. Derivatives are innovative financial instruments having features such as value derivation, leverage, and future settlement. The primary functions of derivatives trade include hedging, speculation, arbitrage, leverage, cost reduction, liquidity, and window dressing. This research is conducted in the context of global scenario rather than for particular economy. It incorporates mixed method approach, which is in line with the theoretical underpinnings of pragmatism philosophy. Primarily, it revolves around qualitative analysis, for which systematic literature review technique is adopted. Purposeful sampling and Snowball sampling strategies are applied for the selection of research paper. Quantitative analysis along with numerical facts about global derivatives trade are presented as empirical evidences; EGARCH technique is applied to investigate the impact of derivatives in enhancing the inflation volatility, whereas VECM is applied to check the causality between spot and futures prices. Case study approach is adopted for the various sections of the thesis. Derivatives contracts generally lack the fundamental constituents of contract theory. Contingent nature of the derivatives allows them to be reported off-balance sheet; modelling based valuation of derivatives is also a complex mechanism. These problematic features have made derivatives an obscured financial product. The regulatory framework for derivatives has number of issues, such as multiplicity of regulations as well as regulators, which create opportunities for regulatory arbitrage. Derivatives are arguably a source of disturbance for real economy; hyperinflation, large scale speculation, exchange rate and interest rate volatility, fragility of financial markets, and banking system etc., get aggravated in the presence of derivatives. Repercussions of derivatives are evident either at larger or smaller scale in various economic crises such as worldwide stock market crash (1987), Japanese Asset Price Bubble (1986-1994), East Asian Currency Crisis (1997), Dot-com Bubble (1996-2001), and Subprime Crisis (2007). Corporations such as Enron, and Hedge Funds like LTCM, were also the victims of derivatives. Subprime Crisis was transformed into Global Financial Meltdown of 2008 mainly because of unprecedented trading volume of derivatives. The domination of derivatives trade has inculcated immense systematic risk in the contemporary global financial setup.
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